How to Invest Small Amounts of Money Wisely

This article was co-authored by Michael R. Lewis. Michael R. Lewis is a retired corporate executive, entrepreneur, and investment advisor in Texas. He has over 40 years of experience in Business & Finance.

There are 20 references cited in this article, which can be found at the bottom of the page.

Contrary to popular belief, the stock market is not just for rich people. Investing is one of the best ways for anyone to create wealth and become financially independent. A strategy of investing small amounts continuously can eventually result in what is referred to as the snowball effect, in which small amounts gain in size and momentum and ultimately lead to exponential growth. To accomplish this feat, you must implement a proper strategy and stay patient, disciplined, and diligent. These instructions will help you get started in making small but smart investments.

Ensure investing is right for you. Investing in the stock market involves risk, and this includes the risk of permanently losing money. Before investing, always ensure you have your basic financial needs taken care of in the event of a job loss or catastrophic event.

Make sure you have 3 to 6 months of your income readily available in a savings account. This ensures that if you quickly need money, you will not need to rely on selling your stocks. Even relatively "safe" stocks can fluctuate dramatically over time, and there is always a probability your stock could be below what you bought it for when you need cash.

Ensure your insurance needs are met. Before allocating a portion of your monthly income to investing, make sure you own proper insurance on your assets, as well as on your health.

Remember to never depend on investment money to cover any catastrophic event, as investments do fluctuate over time. For example, if your savings were invested in the stock market in 2008, and you also needed to spend 6 months off work due to an illness, you would have been forced to sell your stocks at a potential 50% loss due to the market crash at the time. By having proper savings and insurance, your basic needs are always covered regardless of stock market volatility.

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Choose the appropriate type of account. Depending on your investment needs, there are several different types of accounts you may want to consider opening. Each of these accounts represents a vehicle in which to hold your investments.

A taxable account refers to an account in which all investment income earned within the account is taxed in the year it was received. Therefore, if you received any interest or dividend payments, or if you sell the stock for a profit, you will need to pay the appropriate taxes. As well, money is available without penalty in these accounts, as opposed to investments in tax deferred accounts. [1][2]

A traditional Individual Retirement Account (IRA) allows for tax-deductible contributions but limits how much you can contribute. An IRA doesn't allow you to withdraw funds until you reach retirement age (unless you're willing to pay a penalty). You would be required to start withdrawing funds by age 70. Those withdrawals will be taxed. The benefit to the IRA is that all investments in the account can grow and compound tax free. If, for example, you have $1000 invested in a stock, and receive a 5% ($50 per year) in dividends, that $50 can be reinvested in full, rather than less due to taxes. This means the next year, you will earn 5% on $1050. The trade-off is less access to money due to the penalty for early withdrawal.[3]

Roth Individual Retirement Accounts do not allow for tax-deductible contributions but do allow for tax-free withdrawals in retirement. Roth IRAs do not require you to make withdrawals by a certain age, making them a good way to transfer wealth to heirs. [4]

Any of these can be effective vehicles for investing. Spend some time learning more about your options before making a decision.

Implement dollar cost averaging. While this may sound complex, dollar cost averaging simply refers to the fact that -- by investing the same amount each month -- your average purchase price will reflect the average share price over time. Dollar cost averaging reduces risk due to the fact that by investing small sums on regular intervals, you reduce your odds of accidentally investing before a large downturn. It is a main reason why you should set up a regular schedule of monthly investing. In addition, it can also work to reduce costs, since when shares drop, your same monthly investment will purchase more of the lower cost shares.

When you invest money in a stock, you purchase shares for a particular price. If you can spend $500 per month, and the stock you like costs $5 per share, you can afford 100 shares.

By putting a fixed amount of money into a stock each month ($500 for example), you can lower the price you pay for your shares, and thereby make more money when the stock goes up, due to a lower cost.

This occurs because when the price of the shares drops, your monthly $500 will be able to purchase more shares, and when the price rises, your monthly $500 will purchase less. The end result is your average purchase price will lower over time.

It is important to note that the opposite is also true -- if shares are constantly rising, your regular contribution will buy fewer and fewer shares, raising your average purchase price over time. However, your shares will also be raising in price so you will still profit. The key is to have a disciplined approach of investing at regular intervals, regardless of price, and avoid "timing the market".

After a stock market crash, and before the stock market recovers (recoveries rise slower than crashes), consider increasing your 401k contribution by a few percent. This way you will take advantage of low prices and not have to do anything else but stop the extra contribution a couple of years later.

At the same time, your frequent, smaller contributions ensure that no relatively large sum is invested before a market downturn, thereby reducing risk.

Explore compounding. Compounding is an essential concept in investing, and refers to a stock (or any asset) generating earnings based on its reinvested earnings.

This is best explained through an example. Assume you invest $1000 in a stock in one year, and that stock pays a dividend of 5% each year. At the end of year one, you will have $1050. In year two, the stock will pay the same 5%, but now the 5% will be based on the $1050 you have. As a result, you will receive $52.50 in dividends, as opposed to $50 in the first year.

Over time, this can produce huge growth. If you simply let that $1000 sit in account earning a 5% dividend, over 40 years, it would be worth over $7000 in 40 years. If you contribute an additional $1000 each year, it would be worth $133,000 in 40 years. If you started contributing $500 per month in year two, it would be worth nearly $800,000 after 40 years.

Keep in mind since this is an example, we assumed the value of the stock and the dividend stayed constant. In reality, it would likely increase or decrease which could result in substantially more or less money after 40 years.

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Part 1 Quiz

If you want to invest money without paying taxes on the amount right away, which account should you open?

A taxable account.

Not quite! A taxable account requires that you pay taxes on the investment income earned the year it is earned. However, a taxable account is an excellent option if you think you'll need to access the money before retirement, as there are no penalties for withdrawing funds early. Guess again!

An IRA.

Yes! An IRA, or Individual Retirement Account, allows you to contribute money as tax deductible. However, because you do not pay taxes on the money right away, you may pay higher interest rates when you start withdrawing the money during retirement. Read on for another quiz question.

A Roth IRA.

Try again! A Roth IRA, or Individual Retirement Account, does not offer tax-deductible contributions. However, you can withdraw your money tax-free when you retire. Click on another answer to find the right one...

Avoid concentration in a few stocks. The concept of not having all your eggs in one basket is key in investing. To start, your focus should be on getting broad diversification, or having your money spread out over many different stocks.[5]

Just buying a single stock exposes you to to the risk of that stock losing significant value. If you buy many stocks over many different industries, this risk can be reduced.

For example, if the price of oil falls and your oil stock drops by 20%, it is possible that your retail stock will increase in value due to customers having more spending money as a result of lower gas prices. Your information technology stock may stay flat. The end result is your portfolio sees less downside

One good way to gain diversification is to invest in an product that provides this diversification for you. This can include mutual funds, or ETF's. Due to their instant diversification, these provide a good option for beginner investors.[6][7]

Explore investment options. There are many different types of investment options. However, since this article focuses on the stock market, there are three primary ways to gain stock market exposure.

Consider an ETF index fund. An exchange-traded index fund is a passive portfolio of stocks and/or bonds that aim to accomplish a set of objectives. Often, this objective is to track some broader index (like the S&P 500 or the NASDAQ). If you buy an ETF that tracks the S&P 500 for example, you are literally purchasing stock in 500 companies, which provides enormous diversification. One of the benefits of ETFs are their low fees. Management of these funds is minimal, so the client doesn't pay much for their service.[8]

Consider an actively managed mutual fund. A actively managed mutual fund is a pool of money from a group of investors that is used to purchase a group of stocks or bonds, according to some strategy or objective. One of the benefits of mutual funds is professional management. These funds are overseen by professional investors who invest your money in a diversified way and will respond to changes in the market (as noted above). This is the key difference between mutual funds and ETF's -- mutual funds have managers actively picking stocks according to a strategy, whereas ETF's simply track an index. One of the downsides is that they tend to be more expensive than owning an ETF, because you pay an extra cost for the more active management service.[9][10]

Consider investing in individual stocks. If you have the time, knowledge, and interest to research stocks, they can provide significant return. Be advised that unlike mutual funds or ETF's which are highly diversified, your individual portfolio will likely be less diversified and therefore higher risk. To reduce this risk, refrain from investing more than 20% of your portfolio in one stock. This provides some of the diversification benefit that mutual funds or ETF's provide.

Find a broker or mutual fund company that meets your needs. Utilize a brokerage or mutual fund firm that will make investments on your behalf. You will want to focus on both cost and value of the services the broker will provide you. [11]

For example, there are types of accounts that allow you to deposit money and make purchases with very low commissions. This may be perfect for someone who already knows how they want to invest their money. [12]

If you need professional advice regarding investments, you may need to settle for a place with higher commissions in return for a higher level of customer service. [13]

Given the large number of discount brokerage firms available, you should be able to find a place that charges low commissions while meeting your customer-service needs.

Each brokerage house has different pricing plans. Pay close attention to the details regarding the products you plan to use most often.

Open an account. You fill out a form containing personal information that will be used in placing your orders and paying your taxes. In addition, you will transfer the money into the account you will use to make your first investments. [14]

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Part 2 Quiz

Why should you diversify the money you're investing with a mutual fund?

Spreading out your money has less downside.

Almost! Spreading out your money across multiple stocks means that if some of the stocks go down, but the others stay the same or even go up, you have fewer downsides in the long run. You should consider protecting your investment by diversifying your stocks in a mutual fund, so you have fewer downsides or significant losses. However, this is not the only reason you should diversify your stocks. Click on another answer to find the right one...

Single stocks are riskier.

You're partially right! If you invest all your money in a single stock, and that stock loses significant value, you're at higher risk of losing substantial sums of money. You should try to diversify your portfolio, like with a mutual fund instead of focusing on a single stock so you can protect and grow your money better. Try another answer...

Your investment is more stable.

You're not wrong, but there's a better answer! Diversifying your investments will protect your money, and all your stocks will be more stable. If you invest in a mutual fund, which provides diversification, your investment is more stable because if some of your stocks lose value, your other stocks will likely stay the same or grow, which equals out the loss in value. Click on another answer to find the right one...

All of the above.

Yes! You should consider all these reasons to diversify when you're thinking about what stocks to purchase. You can quickly diversify by buying stock through a mutual fund, which will handle the diversification for you, providing less downside, less risk, and more stability. Read on for another quiz question.

Be patient. The number-one obstacle that prevents investors from seeing the huge effects of compounding mentioned earlier is lack of patience. Indeed, it is difficult to watch a small balance grow slowly and, in some instances, lose money in the short term. [15]

Try to remind yourself that you are playing a long game. The lack of immediate, large profits should not be taken as a sign of failure. For example, if you a purchase a stock, you can expect to see it fluctuate between profit and loss. Often, a stock will fall before it rises. Remember that you are buying a piece of a concrete business, and in the same way you would not be discouraged if the value of a gas station you owned declined over the course of a week or a month, you should not be discouraged if the value of your stock fluctuates. Focus on the companies earnings over time to gauge its success or failure, and the stock will follow.

Keep up the pace. Concentrate on the pace of your contributions. Stick to the amount and frequency you decided upon earlier, and let your investment build up slowly. [16]

You should relish low prices! Dollar-cost-averaging into the market is a tried and true strategy for generating wealth over the long run. [17] Furthermore, the less expensive the stock prices are today, the more upside you can expect tomorrow.

Stay informed and look ahead. In this day and age, with technology that can provide you with the information you seek in an instant, it is tough to look several years to the future while monitoring your investment balances. Those that do, however, will slowly build their snowball until it builds up speed and helps them achieve their financial goals.

Stay the course. The second biggest obstacle to achieving compounding is the temptation to change your strategy by chasing fast returns from investments with recent big gains or selling investments with recent losses. That's actually the opposite of what most really successful investors do. [18]

In other words, don’t chase returns. Investments that are experiencing very high returns can just as quickly turn around and go down. "Chasing returns" can often be a disaster. [19] Stick to your original strategy, assuming it was well thought out to begin with.

Stay put and don’t repeatedly enter and exit the market. History shows that being out of the market on the four or five biggest up-days in each calendar year can be the difference between making and losing money. You won't recognize those days until they've already passed.

Avoid timing the market. For example, you may be tempted to sell when you feel the market may decline, or avoid investing because you feel the economy is in a recession. Research has proven the most effective approach is to simply invest at a steady pace and use the dollar cost averaging strategy discussed above.

Studies have found that people who simply dollar cost average and stay invested do far better then people who try to time the market, invest a lump sum every year on new years, or who avoid stocks. The reason for this is that it takes a decade or so to learn the many pitfalls in investing in stocks, like the emotion that goes with a bull market, exaggerated information, sales groups that are paid to sell and tend to bend the information to look to rosy and just plain fraud. Many brokers will not tell you that 99.9999% of all companies go bankrupt over time, so mutual funds and dollar cost averaging avoids all the bad companies that are removed without you have to do any homework or lose any money. [20]

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Part 3 Quiz

If you purchase less expensive stocks today, what is most likely to happen?

You will have more downsides in the long run.

Not quite! Less- expensive stocks are less risky, so you typically won't have more downside during the life of your stock. Cheaper stocks and dollar-cost-averaging are more stable ways of growing your investment. Try another answer...

You will have more short-term wealth.

Nope! While there are more upsides in the future for less expensive stocks, you aren't likely to have more short-term wealth. Lower-end stocks take longer to produce upsides, but they are also more stable during the time you own the stock. Pick another answer!

You will generate wealth in the long run.

That's right! Purchasing less expensive stocks and dollar-cost-averaging are more likely to generate wealth. It may take longer than you'd like, but if you keep your investment long enough, you will typically see more growth. Read on for another quiz question.

Community Q&A

The stock market can provide good returns provided you are diligent and keep on top of the trends and understand what is happening all of the time. Large sums invested in long-term savings deposits can provide good returns but only over a long time and with a good interest rate. Investing in the growth of a business can provide good returns if the business proves very successful. Managed funds can provide good returns over the long term but be sure to do your research first, to check they’re a solid fund. It’s really best to speak to your financial advisor to get a big picture of how risk tolerant or risk averse you are and get a tailored plan put together that addresses your income stream and wishes.

You could try different things depending on how risk tolerant or risk averse you are. For the risk averse, try a long-term savings deposit with a good interest rate or bonds. For the risk tolerant, try buying stocks or commodities, buy some cryptocurrencies or dabble in peer-to-peer lending. You might also help a startup get going after doing your research into its potential if you have a high risk tolerance. If you want to run your own business, this can be a solid investment and way to make money in the future if your business is successful.

This is a good amount to invest in such things as stocks (shares), a term deposit with a good interest rate, a college savings account, a down payment on your mortgage to speed up repayment, retirement funds and bonds. You could also use it to get rid of bad debt, such as credit card debt, to free you up to actually start saving instead of spending. It’s a good idea to see a financial adviser for this amount, to get the advice tailored to your needs and circumstances.

Certainly, you can invest small amounts of money. However, in order to ensure your investments are worthwhile, you’ll need to invest continuously to build up your investment over time. Moreover, you’ll also need to have a longer term strategy in place that is easy for you to stick to, along with being patient about amassing money over time and diligent about always adding more. The article above provides an excellent outline to follow to get you started investing small amounts of money toward your goal of being financially independent.

It depends on your cost of living and how aggressively you choose to save and invest. Most people can save 10% of their gross income. If you save and invest 10% of your income, that translates to $6,000 or more a year.

To invest few questions need to be answered: Financial Institution: Look for brokerage company which can provide you investment opportunity. You can choose mutual funds (different countries know this financial instrument with different names) or invest based in companies based on your personal judgement. Mutual funds provide you risk and return ratings. In case you want to invest yourself you need to perform financial analysis. usually big companies are low risk low return (blue chip). With personal decisions about stocks, it is higher risk than mutual funds, unless you are a professional financial analyst.

How do I benefit if I sell stocks at a profit, then transfer those funds to another company's stock?

Community Answer

Assuming you have invested $100 and earned a profit of $2 from the initial investment, you have benefited by $2. And supposing you invest the same $2 into another company's stock. Then, you do not have any benefit. Wait for your eggs to hatch!

I want to invest money in a small business. What should I ask for in return?

Donagan

Top Answerer

Vanguard's small-cap Explorer fund has returned 9% annually for 50 years and has more than doubled investors' money in the last ten years, all without much principal risk. If you're going to take the considerable risk of investing in a single, small business, you should expect a return-on-investment much higher than that. Better yet, invest in a "small cap" fund. Most mutual fund companies offer at least one such fund investing in small businesses.

Tips

Ask for help in the beginning. Seek the counsel of a professional or a financially experienced friend or relative. Don't be too proud to admit you don't know everything already. Lots of people would love to help you avoid early mistakes.

If you employer has a 401k program where they match what you invest, it would be crazy not to take advantage of it. It is an immediate 100% return on your money. Banks would never give you $100 for every $100 invested.

It is important to know whether or not we are in an inflationary decade. Inflationary decades favor hard assets like Real Estate and Gold but Dis-inflationary decades favor Stocks. Inflationary decades are marked by prices (like gasoline) rising, a weak dollar and gold rising. During Inflationary decades, Real Estate outperforms the stock market. Dis-inflationary decades are marked by lowering of interest rates, a strong dollar and a strong Stock Market. During dis-inflationary decades, the stock market outperforms Real Estate and Gold.

About This Article

This article was co-authored by Michael R. Lewis. Michael R. Lewis is a retired corporate executive, entrepreneur, and investment advisor in Texas. He has over 40 years of experience in Business & Finance.

To invest small amounts of money wisely, start by opening an account to hold your investments. Next, find a broker or mutual fund company that meets your needs to help you navigate the stock market and explore your investment options. If you want to invest in individual stocks, choose several different stocks and invest a small amount of money into each of them. Avoid concentrating your money in just one or two stocks to prevent any major losses!